What Drives Gold, and Why Should Investors Own It?

“We have gold because we cannot trust governments.” -Herbert Hoover

What Drives Gold, and Why Should Investors Own It?

Gold’s rapid ascent to new record highs calls into question future returns. But when it comes to owning gold, investors should also ask whether gold can outperform bonds or equities, or both?
To answer this, we assess the fundamental drivers of gold’s bull run since 2022. The U.S. Federal Reserve (“Fed”) cutting cycle, sticky inflation, uncertainty and U.S. dollar (“USD”) diversification have been the key drivers since 2022.
We also discuss gold’s role as an inflation hedge, along with tactical tailwinds going forward, namely stagflation (slow growth and rising prices), recession risk and diminishing U.S. exceptionalism.
Finally, we identify the macro risk scenarios for gold outperformance and catalysts for underperformance. Stagflation is arguably the most favorable scenario, the end of inflation fear and trade wars the least.
While some consolidation near-term is possible, gold remains positioned to continue outperforming against a backdrop of sticky inflation, recession risk, de-dollarization (reduced reliance on the U.S. dollar) and budget deficits. These tailwinds are also long-term themes, strengthening the strategic case for gold as investors look to hedge USD and fixed income exposures.

What’s driving gold’s bull run?

Figure 1: Fed cut cycles are a key tailwind for gold

Source: Bloomberg, BMO GAM, January 2025.
There are four factors driving gold’s bull run since 2022.
Fed rate cut cycle: Cross-asset correlations—low equity, negative USD and positive bond correlations—not only enable gold as an effective portfolio diversifier but also explain gold’s strong returns around Fed cutting cycles (Figure 1, 2). Markets started pricing in the latest rate cut cycle in late 2022 when the Fed started slowing the pace of hikes, allowing USD and real yields to peak, sending gold higher. Since peak hawkishness in late 2022, gold has returned around 100%; since the last rate hike and the first rate cut, gold climbed 70% and 25%, respectively.

Figure 2: Cross-asset correlations: Gold as a portfolio diversified

Source: Bloomberg, BMO GAM. Monthly data since 1988, as at April 2025.
Sticky inflation: As economies avoided recessions, inflation remains above central bank 2% targets. Resilient growth and ongoing fiscal deficits mean sticky inflation and a higher for longer interest rate regime, keeping inflation fear alive and driving demand for hedges like gold.
Uncertainty: Gold has a history of outperforming during geopolitical or policy shocks. Russia invasion of Ukraine in 2022 and Israel-Hamas conflict in 2023 saw gold returns average 7% within the first two weeks, outperforming both equities and bonds. Gold also outperformed during the latest trade war that culminated with high tariffs on April 2.
USD diversification: Central banks are an important source of gold demand (Figure 3). We focus more on their motivation, which center on USD diversification and weaponization. Key buyers are emerging market central banks who still have ample room to diversify away from USD toward gold. The largest include China, India, and Turkey, but the scope is broadening into Europe, with Poland the largest buyer in 2024. China began ramping up purchases in 2022, increasing its gold share to 5.5% from 2.0% since 2000, while reducing its USD allocation to 25% from 40%.

Figure 3: USD diversification needs driving central bank demand

Source: World Gold Council, BMO GAM, February 28, 2025.

Gold as an inflation hedge

We see evidence of gold working as an inflation hedge for several reasons. Most importantly, gold adds alpha by outperforming bonds, which are less of a hedge when bond-equity correlations turn positive and deficits surge (Figure 4).

Figure 4: Cumulative returns in gold outpacing bonds since pandemic onset

Source: Bloomberg, BMO GAM. Daily cumulative returns since March 15, 2020.
During the 2022 inflation shock, gold outperformed global equities and global bonds by 20 and 16 percentage points, respectively. Real returns, though negative in USD terms, were positive when priced in other currencies like CAD. Gold-bond correlations, which unsurprisingly dislocated after real yields turned positive, tend to fall when yields rise and even diminish when real yields are always positive, such as prior to 2008 (Figure 5).

Figure 5: Gold vs real yields: Relationship diminishes when real yields are positive

Source: Bloomberg, BMO GAM. Monthly data, 1973-2007.
We see three reasons why cross asset correlations don’t tell the full story when it comes to gold returns. First, gold returns are positive on sharply negative moves in bonds and in equities, acting as a defensive hedge (Figure 6). Second, an uncertainty premium is likely embedded in gold returns. Finally, central bank demand is providing a backstop, observed in daily flow data.

Figure 6: Gold as a defensive hedge

Source: Bloomberg, BMO GAM. Monthly returns since 1973.
We believe gold is well suited for sticky inflation by outperforming bonds in particular, adding alpha to multi-asset portfolios. Historical inflation-adjusted returns demonstrate its store of value (Figure 7). But arguably the best inflation backdrop for gold is stagflation (a low probability event but where odds are currently rising). The only historical example is the 1970s, and real annualized returns surged.

Figure 7: Gold historical real returns

Source: Bloomberg, BMO GAM. Monthly data since 1973.

Gold outlook: gold as a stagflation and recession hedge

We acknowledge gold’s year-to-date returns appear stretched based on its speedy ascent and technical levels relative to 200-day moving averages. But positioning is not crowded or driven by speculative flows. We think the rally reflects several fundamental and strategic drivers that can continue to broaden gold’s investor base.
Stagflation: The U.S. average tariff rate has increased to +20%, which points to a 1.5-2% boost to core inflation and at least a 0.5% hit to growth. Short-term inflation breakevens have room to move higher, and growth forecasts, lower. If significant reflation does materialize, gold is likely to perform better than in 2022 because real yields have already repriced.
Recession: Gold sees higher returns around recessions, when Fed rate cuts are deeper than insurance cut cycles and uncertainty is higher. Recession odds have risen and could move higher. We find gold’s price action more closely resembles not only recession cuts but also 1973-74 recession, which ended in sticky inflation (Figure 8).

Figure 8: Gold vs bond returns suggests a 1970s-style recession

Source: Bloomberg, BMO GAM, as of September 2024
Deficits: Budget deficits increase during recessions because of automatic stabilizers (e.g., unemployment insurance), stimulus and lower revenue receipts. Budget deficits are already high and projected to remain at 6-7% through 2034 without stabilizers, leaving federal debt on a higher trajectory toward 120% of GDP. Should a recession materialize, deficits would widen further—on average by 4 percentage points. A more unsustainable U.S. debt trajectory raises the odds of debt spiral as investors shun Treasuries, driving up interest costs further. Gold would be one of the few safe havens and is correlated to deficit surprises (Figure 9).
USD weakness and end of U.S. exceptionalism: Gold has a strong negative correlation to the U.S. dollar, which peaked in January as U.S. growth projections started declining. We think the Trump administration’s policies are USD-negative (see Make International Great Again), which benefits gold. Tariffs, which reduce trade and therefore demand for USD, threatens USD’s reserve status, underpinning central bank demand as well as private flows which have picked up meaningfully and where the market continues to expand.

Figure 9: Gold returns positively correlated to higher deficit projections

Source: Bloomberg, BMO GAM. Annual data since 2008 to 2024.

Summary and outlook: scenarios where gold outperforms in a multi-asset portfolio

Gold addresses key investment pillars as a diversifier, store of value, defensive and inflation hedge. The current tailwinds for gold center on rising risks of stagflation, recession and U.S. underperformance, which in turn raise the odds of a more unsustainable U.S. debt trajectory (Figure 10). These themes can drive secular demand as investors look to hedge USD and fixed income exposures.

Figure 10: Gold is the ultimate safe haven on a recession-induced debt spiral

Source: Bloomberg, BMO GAM, March 2025.
Gold is best positioned to outperform fixed income if tariffs stay elevated and higher inflation limits the extent of rate cuts. Gold can also outperform in a technical recession, which we believe is more likely than a full-blown recession. In the less likely scenario of resilient growth, gold could outperform as reflation concerns remerge.
We view gold as a recession hedge in this cycle. Indeed, bonds are usually the cleanest hedge as the Fed cuts aggressively. However, as the current growth shock embodies an inflation shock and high deficits, bonds are less attractive given risks around Fed policy and government issuance.
Where may gold underperform? The most immediate catalyst is a Trump policy pivot or swift trade deals that lower tariffs significantly. But scenarios where inflation fears diminish or U.S. budget deficits decline are the trends to watch. Goldilocks scenarios where inflation drifts back to 2% amid sustained economic growth could drive a period of underperformance.
We summarize these scenarios in Table 1.

Source: BMO GAM, 2025.
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Originally Posted May 6, 2025 – What Drives Gold, and Why Should Investors Own It?

Portfolio implications:

We initiated gold allocations to our portfolios in 2020. As of April 2025, we continue to hold allocations averaging 2.5% across our flagship managed solutions and have hedged the recent runup with options.

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